Personal pension
schemes
The basic state pension, for an individual, is
currently £79.60 a week.
To boost your income in retirement, you need to
make your own arrangements. At present your
choices are as follows. You may be able to join a
company (or ‘occupational’) scheme (see
Company pension schemes, HR 7). You may
be happy to use a stakeholder pension scheme
(see Stakeholder pensions, HR 33). The third
alternative is to take out some other form of
personal pension scheme.
Tax relief, and, in some cases, National Insurance
rebates, will boost the amount you can invest in
pensions. But longer life expectancy means you
need to invest as much as you can, as efficiently
as you can, for a comfortable income after
retirement.
The tax regime for pensions is to be simplified
from April 2006 with a lifetime limit and an
annual limit on tax-favoured contributions
replacing the current complex web of tax
restrictions. However you should not miss out on
the opportunity to use tax relief and build up
income in the meantime.
This briefing explains:
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Who should take out a personal pension.
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How much to pay in.
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How to choose a scheme.
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Where to go for advice.
Should you have one?
The sooner you start saving for retirement, the
better. But check any long-term contracts. Nearly
all modern pension schemes permit you to move
your money out without charges, but others
have penalties.
A Certain people are generally advised to
make their own pension arrangements:
B
◆
Anyone who would otherwise rely solely
on a state pension.
Even if the basic pension is supplemented
by a State Second Pension (formerly
SERPS), this will not normally pay for a
comfortable retirement (see National
Insurance and state pensions, TA 2).
◆
The self-employed.
If you belong to a company pension scheme,
you might be able to use a personal pension
scheme to top it up.
◆
Most members of company schemes can
currently save up to £3,600 (gross) each
year through personal pensions.
◆
Opting out of a company pension into a
1C), you can currently pay up to £3,600 a
year (the ‘earnings threshold’) into
personal pension schemes, whatever your
income. The £3,600 limit applies to the total
of contributions to personal pension
schemes (including contributions to
stakeholder schemes).
personal pension is unlikely to make sense,
because company schemes generally offer
better benefits, most notably the
employers’ contribution (see Company
pension schemes, HR 7).
C
Some people are excluded from investing
in personal pensions.
◆
◆
Those who are aged over 75.
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Those who are not resident in the UK for
tax purposes (except for Crown Servants
serving abroad, or their spouses).
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People who belong to their company’s
pension scheme and who are also
controlling directors, or have been at any
time in the preceding five years.
◆
C
People who belong to their company’s
pension scheme and who have also
earned over £30,000 a year in each of
the preceding five years.
Tax breaks
You may be able to pay in more than the
earnings threshold if you are not a member
of a company pension scheme.
◆
You can pay in a percentage (depending
on your age) of your earnings up to
£102,000 (the ‘earnings limit’ for
2004/05).
◆
This maximum contribution limit gradually
increases from 17.5 per cent of Net
Relevant Earnings if you are age 35 or
under, to 40 per cent of earnings if you
are age 61 or over.
◆
Different rules apply to pre-July 1988
personal pensions (known as retirement
annuity contracts). Only earnings-related
contributions are allowed and the
contribution limits rise from 17.5 to 27.5
per cent of all earnings.
◆
You will have to provide evidence of
your earnings if you wish to pay more
than £3,600 each year.
◆
You can base your contributions on your
highest earnings in the previous five years.
Tax relief on your contributions to personal
pension arrangements will boost your savings.
A You will receive tax relief at up to your top
rate.
◆
◆
B
Tax relief at basic rate (22 per cent) is now
given automatically. So you only have to
pay in £78 to get £100 invested in your
pension.
Higher-rate taxpayers are entitled to relief
at 40 per cent on their contributions. The
individual must claim the additional 18 per
cent tax relief back through selfassessment tax returns.
D You can usually take out up to 25 per cent
of your accrued personal pension fund
tax-free on retirement.
◆
Unless you are barred from joining at all (see
Your dependants
You can provide for your dependants by
taking out a personal pension plan.
E
A A lump sum will be paid to your heirs if
you die before retirement.
◆
B
This will usually be the value of your
fund at the date of death, or — very
rarely — your contributions plus interest
or bonuses.
You can use up to 10 per cent of your
allowable contributions to take out life
assurance, to give separate lump sum
cover should you die before taking
benefits.
◆
These payments qualify for tax relief,
unlike most life assurance premiums.
Even people with no income at all can
pay in up to the earnings threshold.
The rest of the pension fund must be used
to buy an annuity, or, until not later than
age 75, to provide retirement income by
means of income drawdown or income
withdrawal (where income is drawn from
accrued capital). This is taxed as earned
income.
In order to qualify for tax relief, you cannot
usually receive your pension before age 50.
This is due to rise to 55 by 2010.
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You can choose to take your pension at
any time between the ages of 50 and 75.
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If you have more than one pension plan,
they can be paid at different ages.
How much to pay in?
A The general rule is to pay in as much as
possible, as rising life expectancy means
retirement can last a long time.
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B
Ideally, you might plan to start paying 10
to 15 per cent of your pre-tax salary into
your pension, before age 25, in the hope
of getting a pension of two thirds of your
final salary by the time you are 65.
◆
B
The minimum you can invest in most
personal pensions is £30 to £50 monthly,
or £500 to £1,000 as a lump sum.
You can invest smaller amounts in
stakeholder pensions (see Stakeholder
pensions, HR 33).
In theory, you should start contributing to
a pension as soon as possible.
◆
take professional advice before
committing to a fund.
Compare the pension plan’s charges with
the charges of other plans. High costs can
reduce your pension significantly.
◆
C
A five-year delay in starting a pension, for
example, from age 40 to 45, could reduce
your final pension fund by almost 40 per
cent.
You may be able to make additional
contributions which you can claim against
the previous year’s unused tax allowances.
Flexibility is important, as the future is not
predictable. The change in the tax regime in
2006, for example, might generate
interesting new possibilities.
◆
Can you suspend contributions, or reduce
or increase premiums? Are there financial
penalties for doing so?
◆
Can you transfer your pension, with little
financial penalty, to a new scheme?
The ‘transfer value’ of different plans with
the same value can vary dramatically.
Most modern schemes allow you to
change contributions or transfer your
fund without financial penalties.
What to look out for
Your retirement income depends on the age
at which you retire, how the fund performs,
charges deducted along the way and future
annuity rates.
A Choose a pension fund with a sound track
record of investment performance.
◆
D People with irregular income may choose
to pay single (lump sum) contributions,
rather than regular contributions.
◆
There is no guarantee that a fund will
continue to be a top performer. Always
Contracting out
The State Second Pension offers benefits to
people earning up to £11,200 a year, who
cannot usually afford personal pensions.
People earning more than that are encouraged
to ‘contract out’, through rebates of their
National Insurance contributions.
E
B
The rebate is an age-related percentage
of earnings that rises as you get closer to
retirement. It has also been designed to
be more favourable to low-earners.
◆
With a ‘rebate-only’ pension, you pay
in no premiums, other than the NI
rebates.
Whether you are better off contracting
out or not depends on your age and
earnings.
◆
This is to avoid paying penalties for
stopping and starting contributions in
longer-established schemes.
Interest rates when you retire will affect
the pension you receive. Annuity rates are
determined by long-term interest rates.
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If long-term interest rates are high when
you retire, you will get a good pension.
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If long-term interest rates are low, your
pension will be relatively poor.
◆
You can delay buying an annuity up to
age 75 and instead take ‘income
withdrawal’. This lets you preserve your
capital and take cash directly from your
pension fund. But you should make sure
you understand the risks of taking this
choice.
Get professional advice before making a
commitment.
◆
If your income at the time you retire will
be sufficient, you can choose to buy a
smaller immediate pension, which protects
against the effects of inflation.
◆
There are plans to increase the flexibility
and extend the types of annuity.
A If you contract out, your NI rebates will
be paid into your personal pension plan
(or stakeholder pension).
◆
Charges cover marketing and selling,
administration and fund management.
In some schemes, initial charges can mean
that only 89p in every £1 of premiums is
invested in your pension in the first five
years.
Take financial advice on your own
specific circumstances.
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See Stakeholder pensions, HR 33.
What kind of pension plan?
Once you have decided on a personal (or
stakeholder) pension, you need to decide what
kind of investment you want. The type of
investment that is right for you depends on the
balance you seek between risk and reward. Your
adviser should explain which plans are right for
you. Ask for evidence to back up this advice.
G Executive pension plans and selfinvested personal pensions (SIPPs) tend to
have higher charges and generally appeal to
higher earners. SIPPs allow greater
investment choices. Executive pension
schemes are classed by the Inland Revenue
as company schemes. See Executive
pensions, HR 9.
A With unit-linked plans, your fund is split
into equal ‘units’, which rise and fall with
the underlying value of the investments.
◆
If your fund is invested in shares, it should
perform well over the long term, but its
short-term value could be very volatile.
◆
You can limit the volatility by investing
through ‘managed funds’, which hold
a wide spread of investments.
◆
Most investors switch to safer cash or
gilt funds as they approach retirement.
B
In a with-profits plan, you get a share in
the profits of the fund, rather than a share
in the fund itself. Your investment is less
vulnerable to stock market volatility, but is
more likely to have penalties if you transfer
the fund to another provider.
C
Most modern with-profits plans are
‘unitised’ — designed to combine the
virtues of both unit-linked and with-profits
plans. For example:
◆
Your fund will be boosted each year by
an annual (or ‘reversionary’) bonus. This
cannot be taken away again, whatever
happens to the stock market.
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You are likely to receive a ‘terminal’ bonus
when you retire. The size of this bonus
is not guaranteed. It depends on the
performance of the stock market and
the company’s bonus policy.
◆
With-profit plans usually do better than
unit-linked when stock markets fall. They
may not do as well when markets rise.
Getting advice
Always shop around and compare investment
performance and charges before you commit
your money. Obtain professional advice.
A Many organisations sell personal pension
plans, including banks and building societies,
unit trust companies, life assurance
companies, friendly societies and
professional advisers.
B
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A company’s agent or sales person will
recommend plans from the company’s
own portfolio or that of partner providers’,
which they believe to be suitable.
Independent financial advisers will search a
variety of providers and recommend a plan
which they believe to be suitable.
◆
Some will receive a commission if you buy
from them, while others will charge a fee.
◆
Check with the Financial Services
Authority that the company or adviser is
regulated under the Financial Services Act
(0845 606 1234 or www.fsa.gov.uk).
The adviser must complete a ‘fact find‘ to
ensure your needs are met.
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C
The adviser must provide you with specific
details about the recommended plan.
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An illustration (not guaranteed) of the
value of your pension on retirement. This
shows what might happen if your fund
grew at 3, 5 or 7 per cent a year.
◆
An illustration of what those figures could
mean in present day money, after allowing
for inflation (the Statutory Money
Purchase Illustration).
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Details of charges and how they will
reduce investment performance, assuming
a set rate of investment growth.
◆
How much the total charges would
amount to over the full-term of the policy.
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How much commission the adviser earns.
D Deposit schemes are generally run by
building societies.
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E
Unit trust and investment trust plans
invest your contributions in pooled
investment funds.
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F
The main benefit is safety. But most
investors will be better off investing
in share-based schemes.
Initial charges may be high, but ongoing
charges may be lower and these plans are
often very flexible.
Stakeholder pensions are personal
schemes designed to be cheap and flexible.
You will be asked questions about your
income, investment aims, marital status
and financial commitments.
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